ACCA - P7 Advanced Audit And Assurance (INT) - Passport ATC - 2009
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AUDIT OF FINANCIAL STATEMENTS
Accountancy Tuition Centre (International Holdings) Ltd 2009 0701
EXAMINATION APPROACH
Considerations in planning and answering questions
Is the matter expected to be material?
Quantitatively or qualitatively? Do not forget
disclosures.
Has it been material historically? Is there any
reason for it to have changed this year?
Ensure you calculate relevant materiality as part of
your answer.
What are the relevant accounting standards?
IFRS, IFRIC or best practice if not yet subject to
any particular IFRS.
Local legislative requirements an other Regulatory
requirements e.g. Stock Exchange rules, National
Central Bank rules.
What are the particular financial statement
assertions that are most at risk? Completeness,
occurrence, accuracy, cut-off, classification,
presentation & disclosure, appropriate carrying value,
rights and obligations, existence. (NOTE: measurement
relates to accuracy, cut-off and classification)
What evidence is expected to be available? Internal
or external? Written or oral? Direct or indirect?
ASSETS
Plant, property and equipment
Materiality
In most enterprises, will be material.
Relevant accounting standards
IAS 16 Property, Plant and Equipment
IAS 17 Leases
IAS 20 Accounting for Government Grants and
Disclaosures of Government Assistance – where an
enterprise sets a grant received against the cost of the
related asset.
IAS 23 Borrowing Cost – where the “qualifying asset”
is eventually recorded as an item of property, plant or
equipment.
IAS 36 Impairment of Assets
IAS 37 Provisions, Contingent Liabilities and
Contingent Assets – where an enterprise makes
provision for decommissioning cost on acquisition.
AUDIT OF FINANCIAL STATEMENTS
Accountancy Tuition Centre (International Holdings) Ltd 2009 0702
IFRS 5 Non-current Assets Held for Sale and
Discontinued Operations
Assertions most at risk
Completeness, e.g. capital expenditure capitalised and
not written off.
Occurrence, e.g. of additions, disposals and impairment.
Measurement of initial expenditure, e.g.:
Self-constructed – consider adequacy of recording
direct costs and directly attributable overheads.
The appropriateness and accuracy of the addition of
borrowing costs.
Purchase price + unrecoverable input taxes +
import duties + other costs associated with
commissioning an asset.
Measurement of subsequent expenditure – added to the
initially measured cost (improvement) or expensed
(repair). The rules of IAS 16 need to be understood.
Presentation – movements in property, plant and
equipment and correct classification. Additional
disclosures if revaluation method used.
Appropriate carrying amount (subsequent)
Appropriateness and accuracy of depreciation –
useful life, residual value and method.
Impairment if necessary – may jeopardise the
adequacy of security if an asset has been pledged.
Revaluation of entire class under allowed
alternative (no “cherry picking”).
Entries to/from a revaluation reserve (or income
statement) on revaluation or impairment.
Rights/obligations, e.g. consider lease agreements to
ensure if nature of a finance lease, then an asset.
Existence – physically inspected by the auditor (internal
and/or external) at the year end.
Evidence
Consider:
Fixed asset register.
Invoices for additions, disposals, repairs/improvements,
other commissioning costs, own constructed assets
(timesheets and costing records).
Professionally carried out valuations.
AUDIT OF FINANCIAL STATEMENTS
Accountancy Tuition Centre (International Holdings) Ltd 2009 0703
Budgets, forecasts, strategic plans, planned asset
management decisions, to support useful life.
Plant/production management with whom valuation and
use issues can be discussed.
Intangible assets
Materiality
Most likely in group accounts following acquisition of
company with previously unrecognised intangible.
Deferred development expenditure is a highly material asset
in the pharmaceuticals sector.
Relevant accounting standards
IAS 38 Intangible Assets
IAS 36 Impairment of Assets
SIC 32 Web site costs
Assertions most at risk
Occurrence – as for non-current assets especially
impairment of development expenditure assets as a
result of technical or market changes.
Measurement (initial) – must meet all of the strict
conditions for asset recognition. Where valuation
models used, the reasonableness of the assumptions
used and the correct application of the model will
require testing.
Presentation – with the required disclosures of IAS 38.
Appropriate carrying amount (subsequent)
Estimate of finite useful life – this is especially difficult
for intangible assets and will be a major item for
inclusion in a letter of representation.
Intangibles carried at an indefinite life will require
an annual impairment review.
Rights – difficult as no physical form. Usually right of
access to economic benefit through legal title and
registration.
Existence
Documents of title and similar (patent registration,
trade mark registration) should be available for
many intangibles.
AUDIT OF FINANCIAL STATEMENTS
Accountancy Tuition Centre (International Holdings) Ltd 2009 0704
Physical inspection of the results of development
work (prototypes, working/demonstration models,
flyers and brochures) may be relevant to confirm
the existence of the capitalised costs.
Essential that carrying value be recoverable
through future economic benefits, otherwise
impairment.
Evidence
Specialist valuations may be available (quotas, patents,
trade marks).
Management representations, corporate plans, etc that
confirm the period of economic life.
Evidence from market research studies, correspondence
with potential customers, initial orders placed – all
would be relevant in determining that the expenditure
does indeed represent an asset.
Invoices and time sheets for the costs that have been
incurred and capitalised.
Goodwill
Materiality
The amount of goodwill will be especially material where the
acquisition is of a company that is highly dependant upon its
“human capital” rather than other assets whose value is
usually attributed upon acquisition.
Relevant accounting standards
IFRS 3 Business Combinations
IAS 36 Impairment of Assets
Assertions most at risk
Completeness, e.g. of amortisation, or perhaps
impairment, may be of concern.
Measurement (initial) e.g.:
Provisions set up for “restructuring”.
Inappropriate application of the detailed fair value
rules of IFRS 3.
Inappropriate use of present values and expected
values to the calculation of the fair value of
deferred (and possibly contingent, consideration).
AUDIT OF FINANCIAL STATEMENTS
Accountancy Tuition Centre (International Holdings) Ltd 2009 0705
Appropriate carrying amount (subsequent) e.g.:
Correct adjustment to the initial calculation of
goodwill where events for the year after acquisition
serve to revise the estimates of fair values of assets
and liabilities acquired, or to revise the estimates of
contingent consideration.
Correct application of impairment tests where
evidence exists of impairment.
Appropriateness of management’s assertion of
indefinite useful life.
Rights/obligations
The obligation to restructure an acquired business
will have to be tested in line with the requirements
of IFRS 3 (and IAS 37).
Complex issues may arise where the investee has
been set up as a “special purpose entity” (SPE), e.g.
what type of interest the investor has, what rights it
has acquired, should the SPE be consolidated.
Existence, e.g.:
What type of investment is being accounted for –
subsidiary, associate, joint venture (JV), SPE.
Share certificates, and confirmation of entries in the
investee’s share register would usually be sufficient
to confirm the ownership of the investment giving
rise to goodwill.
Evidence
Legal correspondence and fee notes for the acquisition
costs. Specialists and “due diligence” reports to assess
fair values of assets and liabilities and useful economic
life of resulting goodwill.
Firm plans and costing for any restructuring provisions.
A statement of financial position drawn up at the date of
acquisition, or calculations supporting a reasonable
prorating of the result for the year, to attribute net asset
values at the date of acquisition.
AUDIT OF FINANCIAL STATEMENTS
Accountancy Tuition Centre (International Holdings) Ltd 2009 0706
Investment properties
Materiality
Will be for property company (income also).
Relevant accounting standards
IAS 40 Investment Property.
IAS 16 Property, Plant and Equipment as IAS 40
allows the use of the “cost method” from IAS 16 and
states that initial measurement of an investment
property is to be at cost.
IAS 36 Impairment of Assets for “cost model”.
Assertions most at risk
Completeness, e.g. rental income and gains/losses from
fair value re-measurement.
Occurrence, e.g. fall in fair values (or impairment) if the
cost model is used. Client may be reluctant to admit.
Measurement, e.g. follow IAS 16 re initial
measurement. Subsequent expenditure – does it
enhance or simply restore the originally assessed
economic benefits?
Presentation e.g. transfers in or out of investment
properties. Detailed rules apply for accounting and
presentation of movements.
Appropriate carrying amount (subsequent) e.g. risk of
overstating property values through inappropriate fair
valuation principles (e.g. development potential rather
than existing use), or though inadequate write down in
the event of impairment.
Rights e.g. IAS 17 may on occasion cause some
difficulty.
Evidence
Real estate agents contracts and completion statements,
legal documents confirming transfer of title, risks and
rewards.
Real estate agents/property valuer’s reports to form
basis for fair value re-measurement (or impairment).
IAS 40 encourages, but does not require (on the
grounds of cost), independent valuation.
Board minutes where a valuation has been carried out
by qualified internal specialists. Assumptions, methods
and a statement as to the expertise of the valuer is
required.
AUDIT OF FINANCIAL STATEMENTS
Accountancy Tuition Centre (International Holdings) Ltd 2009 0707
The receipt of rental income can be verified by
reference to rental contracts and bank account entries.
Analytical procedures for rental income, e.g. proof-in-
total, can be effectively used where a company has a
large portfolio of investment properties.
Investments
Materiality
Unless investment company, unlikely to be material.
Relevant accounting standards
IAS 40 Investment Property – for real estate.
IAS 36 Impairment of Assets
IAS 32 Financial Instruments Disclosure and
Presentation
IAS 39 Financial Instruments Recognition and
Measurement
IAS 18 Revenue
Assertions most at risk
Completeness – of dividend income and related
enhancements (rights, bonuses, etc).
Occurrence will generally be no problem. There may
be established treasury activity rules that provide for
purchase of investments.
Measurement (initial) of acquisition (transaction)
expenses should be included as part of the cost of
acquisition when first recognised.
Presentation. IAS 32 and 39 have detailed and
extensive requirement for the disclosure and
presentation of financial instruments – a checklist is
likely to be used by the auditor.
Appropriate carrying amount (subsequent) e.g.
disclosure (or accounting for under IAS 39) of fair
values of investments at the year end or use of models
for unlisted investments.
AUDIT OF FINANCIAL STATEMENTS
Accountancy Tuition Centre (International Holdings) Ltd 2009 0708
Evidence
Brokers purchase/sale contract notes supported by
authority to purchase/dispose (e.g. in board minutes).
Securities certificates (= document of title) shows
registered holder and denomination of shares. Possibly
held by bank or solicitor.
Stock Exchange quotations at the reporting date.
Independent information services (Extel, Stubbs,
Moody’s, etc) to agree the events that have occurred
during the year (dividends declared, payment date,
rights or scrip issues, stock splits, etc).
Income received (verified by reference to published
reference guides) corroborates existence and ownership.
Management representation (e.g. about intention to hold
or sell).
Inventories
Materiality
For trading/manufacturing companies, inventories are often
the single most material current asset. A highly significant
figure impacting both income statement and statement of
financial position.
Relevant accounting standards
IAS 2 Inventories.
IAS 23 Borrowing Costs – where the “qualifying asset”
is recorded as an item of inventory.
Assertions most at risk
Completeness, e.g. double counting – especially where
items of inventory are physically moving during the
physical count.
Omission, e.g. when items are in transit between
locations or held at third party premises.
Measurement (initial) e.g. application of appropriate
cost formulas to obtain an approximation to cost.
Overheads that are attributable to getting the stock to its
present location and condition, based on normal activity
level, will have to be identified.
AUDIT OF FINANCIAL STATEMENTS
Accountancy Tuition Centre (International Holdings) Ltd 2009 0709
Appropriate carrying amount (subsequent) e.g. lower
of cost and net realisable value (NRV) correctly applied
considering, for example, damage due to environmental
factors, decline in the market, technical obsolescence,
excessive quantities held.
Calculation of NRV is usually problematic, in that it
usually requires estimates of both selling price, costs of
making the sale and rectification costs of the inventory
concerned. Events after the reporting date may help to
crystallize some of these amounts.
Rights, e.g. “Reservation of Title” clauses. Unless there
are serious doubts about going concern, the accounting
treatment is usually to treat such items as being part of
inventory. The amount of inventory that is subject to
such “Romalpa” clauses should be disclosed, if
material, when going concern is in doubt.
Existence, e.g. inventories held at third parties and third
party inventory held at client’s premises
Construction contracts
Materiality
For companies involved in construction contracts the
balances arising will almost certainly be material in the
statement of financial position, and the revenue recognized in
the income statement will similarly be material.
Relevant accounting standards
IAS 11 Construction Contracts
IAS 23 Borrowing Costs – where the “qualifying asset”
is recorded as a construction contract.
Assertions most at risk
Completeness, e.g. misclassify items of plant,
equipment and inventory, as balances arising under
construction contracts. There is also clearly an
“incentive” to incompletely account for any expected
losses on contracts underway.
Measurement (initial) e.g. managements may be
reluctant to account for a foreseeable loss, especially
when a contract has not yet started.
AUDIT OF FINANCIAL STATEMENTS
Accountancy Tuition Centre (International Holdings) Ltd 2009 0710
Presentation, e.g. disclosures required under IAS 11
will have to be checked. It will be important to ensure
that where a client has both “Amounts due from
customers for contract work” and “Amounts due to
customers for contract work”, that these are not netted
off.
Appropriate carrying amount (subsequent) e.g. basis of
calculation may change for a given contract over its
duration. Measurement of % completion is high risk.
Rights/obligations e.g. obligations for “making good”
where contract activity has caused environmental
damage, or simply not been contractually agreed.
Existence, e.g. need to physically visiting a sample of
construction sites, accompanied by appropriate
specialists (e.g. quantity surveyor) to assess the
quantities on site and the % completion of a contract.
Evidence
Contract cost accounts/records, supported by materials
invoices, sub-contractors invoices, timesheets and plant
and equipment hire contracts.
Contracts and variations agreed with clients, to confirm
revenue amount.
Specialist report to assess % completion and any
estimated remedial costs.
Invoices for any billings made to the customers.
Agreed accounting policy for contracts, including the
method by which % completion would be assessed.
Schedules for each contract, detailing contract revenue,
contract costs to date and to complete, % completion,
attributable revenue and costs to date & for the period,
statement of financial position amounts.
Agriculture
Materiality
Unless the enterprise operates in the agriculture industry this
area is unlikely to be material.
Relevant accounting standards
IAS 41 Agriculture
IAS 16 or IAS 40 when dealing with land.
IAS 38 when dealing with intangible assets.